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Is there such a thing as Acquisition Rationale? Part 1

How can you make sense of Acquisitions and where can you start if you want to devise an M&A Strategy?

In this blog post I will suggest that it is possible to set out a framework which you can use to establish and explain an acquisition rationale.

In this discussion we must start with the two protagonists – the Acquirors and the Target Companies. These are shown in the diagram below.

There are Six Key Issues to be addressed:

1. Ability to Execute

2. Financial Resources

From the Acquirors perspective it is important at the start to establish that the company has the ability to execute a transaction. Secondly we need to understand the financial resources available to the company for an acquisition.

From the Targets’ perspective we need to evaluate their NEED for money, either personally or for the continued development of the company and their commitment to a course of action if they are approached to sell the business.

Without a willing buyer and a willing seller (or a real motivating factor on behalf of the seller) it is most unlikely that a deal could be closed.

The next issue, Intent has four sub topics; from the Acquirors Perspective – Strategy and Sector preferences and from the perspective of the Target we need to consider Stage of Development and Scale.

Acquirors Intent

3. Strategy

4. Sectors

Targets Intent

5. Scale

6. Stage of Development

In diagramatic form these can be set out follows:

Lets look at these in a more detail.

Acquirors Ability to Execute

This asks the question: Does the company actually have the skills and motivation to commit to a complex and time consuming transaction?

This asks questions of the CEO, the Board, the company’s shareholders (who may be required to approve and to provide financial support for the deal). It is worth looking at the company’s track record to see if they have successfully made an acquisition in the past and if not have they appointed suitable advisers or an internal M&A team to handle the deal.

It is also worth asking the question of the CEO, WHY the company feels it needs/wants to make an acquisition to begin to understand his motivation; more will be said about this when we come to look at strategy.

Acquirors Financial Resources

One of the major limiting factors will be the financial resources available to the company to pay for a deal. This may include:

Cash

Equity

Preference shares

Convertibles

Bank Debt

Or a Combination of the above.

The financial resources equation enables us to evaluate the size of deal we should be seeking to identify, with a minimum as well as a maximum. When we come to evaluate targets we will be able to use this to screen out unsuitable candidates.

Now we have to examine these two factors from the other perspective; that of the Target.

Target Ability to Execute

Again this is all about motivation; are the Board of the Target and their shareholders prepared to commit to an exit when their alternative may be an additional funding round. This will depend on their joint and several objectives and whether they believe that a trade sale of the company is the right thing to do at this point.

If the company is performing well an IPO might be an alternative.

From the Acquirors point of view, it is always preferable to find the Target in a position where they need to do a deal, whatever that motivation is.

Target’s Financial Resources

This considers whether the Target company, its Board or its Shareholders either need money or wish to cash out and realise their investment.

Capital may be required for the continued development of the business which requires either a financial investor or a trade investor with those resources.

Every company, in practice, is potentially for sale, its all about the price and the investors in the Target may have concluded that this is the right time to sell and cash out.

So to summarise, the Acquirors must be both capable and motivated and have the financial as well as the talent to make an acquisition. It is important to recognise that these are not assumptions that can be made and accepted without questioning the management and particularly the CEO.

From the other perspective, that of the Target, there must be a genuine motivation on their part too. Even if they receive an attractive unsolicited approach, without such a motivation, it is much more likely that the “Do Nothing” scenario will prevail.

In Part 2 of this series I will look at the Four Factors of Intent from the perspective of the Acquiror.

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